Remarks of Under Secretary of Commerce Eric L. Hirschhorn at the Practicing Law Institute

Prepared Remarks of Eric L. Hirschhorn Under Secretary for Industry and SecurityU.S. Department of Commerce

Practicing Law Institute Washington DC December 10, 2012

Thank you for the introduction and for the opportunity to provide an update on President Obama’s export control reform initiative—an effort that is reaching flood tide.

My department and our counterparts across the federal government have been working hard these past three years on the initiative. This truly has been a cooperative effort. Given last month’s election results, we have time to finish the largest part of the reform effort—the transfer to the Commerce Control List of defense articles that do not warrant control on the US Munitions List—and also to make other improvements to our system. Having a second term gives us the chance to consider and address those tasks as well.

I know many of you are familiar with the reform initiative, but let me briefly describe why we are doing this and what each change entails. I will then provide an update on where we stand today and offer a preview of some potential activities in the second term.

Why Reform U.S. Export Controls? As still best described in a speech Secretary of Defense Gates gave in April 2010, national security requires that we fundamentally reform the current export control system. National security in this context essentially means three things: First, the system must enhance interoperability with our close allies. Second, it must reduce the current incentives manufacturers in allied countries have to design out or avoid US-origin content, which will thus help the U.S. industrial base. Finally, it must allow us to focus our limited enforcement and licensing resources on the transactions that matter the most rather than on those that are routinely approved, such as for many items for ultimate end use by governments of close allies.

The Administration has developed a plan to implement these national and economic security objectives: Revise the U.S. Munitions List to clearly and positively identify those items that provide the United States with a critical military advantage or that otherwise warrant case-by-case licensing to essentially all destinations. Control all the remaining items specially designed for military applications on the Commerce Control List, which allows for conditioned licensed exceptions for exports to close allies and strict prohibitions and controls on exports—and reexports—to other countries.

That’s the essence of the plan. Getting to final revisions to the ITAR and the EAR to implement this plan is, however, quite complex. Led by the Defense Department, hundreds of experts with varied backgrounds in multiple bureaus and the military services have reviewed thousands of controls that are decades old involving hundreds of thousands of articles involving just about every area of technology. Many of these articles are today caught up in non-specific “catch-all” controls that had never been analyzed before and that result each year in tens of thousands of license applications and hundreds of thousands of classification, jurisdictional, licensing, and other compliance determinations that affect billions of dollars of export trade. All these reviews then must be filtered through a determination of what controls are in our national security, foreign policy, and other interests—topics that have multiple and different variables for the tens of thousands of items and dozens of different destinations, end uses, and end users at issue.

Section 38(f) of the Arms Export Control Act requires the President to periodically review the U.S. Munitions List and determine which items continue to warrant the controls of the ITAR. Thus, the experts were asked to answer, for the items on the USML, questions like:

Is it inherently military?

Is it almost exclusively available from the United States and its close allies?

Does it provide the United States with a critical military or intelligence advantage or otherwise warrant the ITAR’s strict controls?

Is it the type of item that we routinely approve for export for ultimate use by our NATO and other multi-regime allies without concern?

Have we described the revised controls in a way that will not lead to unintended consequences, such as over-controlling or under-controlling something?

These determinations then needed to be reduced to regulatory text in ways that the public and government officials could understand in two different, complex sets of regulations with varied histories and requirements that have accreted over the decades. Then, every proposed change had to be reviewed by policy, regulatory, and legal experts in at least five different departments, primarily Commerce, State, Defense, Homeland Security, and Justice. Each change, correction, or second thought then needed to be recirculated for additional reviews.

All these proposed changes then need to be published in the Federal Register for public comment, which can take time given that there are many other agencies publishing rules as well. After receiving these comments, the departments then review them, decide which ones we will accept and why, prepare summaries, edit the proposed regulatory text as needed, and then repeat the entire review and clearance process set forth above. All the while, we must keep in mind the ultimate objectives of the reform effort that Secretary Gates laid out in April 2010, the relevant statutory limitations or requirements, enforcement considerations, congressional notification requirements and related issues, and our international commitments.

In the end, our plan will accomplish the national security objectives, in part, by making it easier for U.S. companies, especially small and medium-sized businesses, to engage in secure trade, particularly with NATO countries and other close allies. This has the tangible benefit of bolstering the security of supply from small companies that are second and third tier suppliers to the U.S. and our allies. At the same time, we are ensuring that the nation’s export control system prevents items from ending up where they should not.

Not all the changes pertain to licensing and license exceptions. Even for trade with countries that are not in NATO or one of the other multi-regime allies within the scope of our new Strategic Trade Authorization License exception, there are benefits for U.S. companies. For example, for small business owners, the removal of registration fees will directly affect their bottom line because the Export Administration Act (EAA) prohibits Commerce from charging licensing fees. Right now, those subject to the ITAR are required to pay a $250 fee to the State Department to export an item, regardless of its value. For a low value item, this can eliminate the profit and any reason to export it. Moreover, U.S. manufacturers of defense articles are required to pay $2250 each year even if they do not export the defense articles they make.

In addition, the EAR, unlike the ITAR, allow for the application of a de minimis rule. An item that is ITAR controlled is always ITAR controlled, regardless of sensitivity, age, availability, or incorporation into a civil item or a foreign-made item. This is the so-called “see-through” rule that creates an incentive for foreign companies to avoid even small amounts of U.S.-origin parts and components in order to avoid needing U.S. State Department approval to transfer, even among close allies, foreign-made items containing small proportions of U.S.-origin parts.

With some exceptions, under the EAR, foreign-made items with controlled U.S.-origin content constituting 25 percent or less Commerce-controlled U.S. parts will not be subject to U.S. export controls. Thus, for example, a U.K. company that has purchased U.S.-origin parts and components specially designed for a U.K.-made defense article will be able to transfer that item to, for example, Germany in accordance with U.K. law without needing also to get an authorization from the U.S. Government. If the Defense Department has determined that a particular U.S.-origin item is so sensitive that it warrants complete U.S. government control regardless of its relative value to a foreign-made end item, then it will be identified on the revised U.S. Munitions List.

The primary exception pertaining to the EAR’s de minimis rule pertains to reexports to China and other countries subject to United States arms embargoes of items that have not been identified as warranting control on the USML but that are nonetheless specially designed for military application. In those cases, the status quo will remain in that there will be a zero de minimis level for reexports to those countries. This means that it will continue to be illegal under U.S. law for foreign persons to export—to China and other countries subject to arms embargoes—foreign-made end items containing any U.S.-origin content that itself was specially designed for military applications or otherwise identified in the CCL’s new “600 series” entries that control former USML items.

Where Export Control Reform Stands Today As outlined by President Obama in August 2009 and then later by Secretary Gates, our ultimate vision for a new export control system remains one with a single licensing agency administering a single list, operating on a single information technology (IT) platform, and enforced by a single export enforcement coordination agency. This objective, however, will require legislation to complete.

Meanwhile, we are doing everything we can to reap the national security benefits of the larger plan within the existing system. We are also making the proposed amendments with an eye to the ITAR and the EAR and their control lists one day being consolidated. This, for example, is why we are developing common definitions and exemptions. Such work not only builds a better functioning, more coherent system but is also a prerequisite for one day creating a single list and single set of control regulations.

Commerce, State, and Defense have agreed on almost all the proposed revisions of control list categories. BIS and State have published 24 proposed rules covering categories of the ITAR and EAR, including the proposed “specially designed” and transition rules. The proposed rules cover such categories as military aircraft, engines, explosives, naval vessels, tanks and military vehicles, protective personnel equipment, auxiliary military equipment, and submersibles.

On November 28th, we and the State Department published proposed rules on military electronics that are open for public comment. Six more pairs of control list rules are in the Office of Management and Budget (OMB) interagency review process. I want to thank those of you who have been commenting on our proposals and encourage you to continue to do so. We take public comments very seriously. Your expertise is crucial for us to make sure we get this right.

We are moving toward publishing our first final rule on our revisions to control list categories. This rule will combine all previous proposed rules on the structure of the new system, plus the new Commerce and State controls on military aircraft, military engines, and related parts and components. Thus, the draft final rule includes (1) the structure for the new “600 series” in the CCL to control former USML items, (2) the rules for how License Exception STA and other exceptions will or will not apply to the export of 600 series items, (3) the new definition of “specially designed,” (4) changes to EAR license exceptions to make them more consistent with the ITAR’s exemptions, (5) new license validity terms to align them with the ITAR (4 years instead of 2, for example), and (6) the rules for transitioning or grandfathering into the new system ITAR licenses covering items that become subject to the EAR.

Before any items can be transferred from the USML to the CCL, the State Department is required under Section 38(f) of the Arms Export Control Act to notify its congressional oversight committees. Each notification must be made at least 30 days before the President implements the proposed changes to the control lists. We have held many meetings with our congressional committees of jurisdiction to keep them up to speed on the reform effort in preparation for the “Section 38(f)” notifications. We expect the State Department will send the first “Section 38(f)” notification sometime in the next several months.

Satellites are a special case. In May, the House passed legislation that would restore the President’s authority to transfer satellites, like other USML items, to the CCL. We had concerns with some provisions of the House language and have worked closely with members and staff of both parties to address those concerns. We are optimistic that the final Defense authorization bill will provide the President with appropriate authority while ensuring that national security is fully protected.

In addition to the publication of proposed rules and our efforts on satellites in Congress, we have taken a number of steps to improve our export control system this first term. This includes: (1) creating License Exception Strategic Trade Authorization (STA) for most items subject to the EAR; (2) improving our export enforcement capabilities; (3) addressing key operational issues, such moving toward the USXports I.T. platform, which we expect to have in “initial operation capability” for all export control agencies shortly; and (4) establishing and training the Munitions Control Division within BIS in anticipation of the movement of items that no longer warrant ITAR control.

We’ve also enhanced enforcement capabilities within BIS and across the U.S. government. This is partly the result of the establishment of the Information Triage Unit (ITU) and Export Enforcement Coordination Center (E2C2), which have enhanced our intelligence abilities and interagency collaboration.

We have obtained permanent law enforcement authority for our export enforcement agents and have focused our enforcement investigations on not only companies that violate our regulations, but also individuals. No longer will an individual be able to intentionally violate the EAR and leave the company’s shareholders to foot the bill, while he banks his commission.

It is worth noting that, in our enforcement, we are trying to make a distinction between “oops” and “the heck with you”—meaning that we are focusing on the truly bad actors, not those who had a decent compliance program, made a mistake, and are working with us to remedy the situation.

This is why we are enhancing our educational programs. BIS is developing a targeted and multi-faceted outreach program to support the USML-to-CCL process and to get exporters up to speed once these changes are published in final form. We also have deployed on the BIS website an interactive tool to assist companies in determining whether they are eligible for and compliant with STA.

Transferring certain defense articles from the USML to the CCL does not degrade the U.S. Government’s enforcement capabilities. If anything, it enables more enforcement tools to be applied to those items. The criminal penalties for violations of the ITAR and violations of the EAR are the same—a fine of $1 million and up to 20 years imprisonment, per violation.

Under the Commerce authorities, the Government has more administrative enforcement tools to apply to violators, especially overseas violators who may be beyond the reach of extradition. These include: temporary export denial orders, plus inclusion on Denied Persons List, Entity List, or Unverified List. Under our plan, there will be more law enforcement resources available in that the regulations will be enforced by criminal investigators from three agencies: Commerce, FBI, and DHS.

Next Steps On the export reform front, our priority is completing the USML list review effort. Although the drafts of each category are written, we still need to publish the few remaining categories in proposed form, work through public comments on all categories to put together final versions, notify Congress of each category change, and make the changes in the revised USML and “600 series” ECCNs with all of the other edits to the ITAR and EAR necessary to allow for the change.

There will be a massive amount of work needed in 2013 to ensure that licenses are processed no less quickly than under the current system. In addition, we will be engaging in educational outreach effort over the next year to help companies respond to changes to the system. This will include more specialty training programs and remote training opportunities. The proposed changes will benefit national security, foreign policy and industrial security, but the transition will be difficult in the short term and we want to help companies successfully respond to the new environment.

Because of the relative size and significance of the national security issues pertaining to the USML that I’ve described today, there thus far has been relatively little focus on EAR-specific improvements or updates, other than License Exception STA and the regular regime-related modifications. Our priorities were right for the President’s first term, but we now are to have a second term and we will be working to modernize many parts of the EAR that do not require regime involvement. We are already beginning this process with the publication on November 29th of our proposed CCL “clean-up” rule, which describes ways to make the CCL more user-friendly for exporters. The proposed rule, in many respects, reflects public comments in response to an Advance Notice of Proposed Rulemaking from December 9, 2010. We encourage you to provide comments on the CCL proposal, which are due January 28th.

Other topics that warrant serious attention include encryption controls and deemed export requirements. We are working now with our advisory committees and our colleagues in the other agencies to develop a priority list of EAR-specific tasks that can be undertaken in 2013 and in the second term.

We will apply the same general standard that has governed our work thus far—achieve greater regulatory efficiency and rationality, focus controls on the most significant items and destinations, increase education to sensitize exporters to their compliance responsibilities, and strengthen enforcement. It has been a pleasure to be a part of this effort and I look forward to continuing it as the President begins his second term.

Thank you for your time and interest. I would be happy to take a few questions.